Which key deductions and credits will not be available to taxpayers on this year’s return?
One of the primary changes is an increase in the threshold for deducting medical expenses brought about by the ACA.
Under the old rule, taxpayers who itemize could deduct medical expenses exceeding 7.5% of their adjusted gross income, or AGI. Obamacare has increased this threshold to 10%. For example, an individual with an adjusted gross income of $50,000 can only deduct expenses over $5,000, rather than the $3,750 limit that would have applied under the old rule.
The primary exception is that the 10% threshold does not yet apply to people aged 65 and over and their spouses. These folks may continue to use the 7.5% threshold through tax year 2016, at which time they will default to the 10% framework along with everyone else.
Other key tax breaks that we lost this year are geared primarily toward higher-income households.
We also lost several other popular tax breaks at the end of 2013, which some of us will feel when we file our 2014 returns next year. The higher-education tuition deduction, which allowed taxpayers to deduct between $2,000 and $4,000 of qualified tuition expense, expired at the end of 2013, as did the health care coverage tax credit.
IRA owners aged 70 1/2 and older can no longer distribute up to $100,000 of IRA funds tax-free to charitable organizations. As of 2014, those distributions must be taxed as ordinary income to the account owner before they can go to charity. Teachers are losing above-the-line deductions of up to $250 for unreimbursed educational expenses.
Homeowners also may feel a pinch. As of 2014, homeowners can no longer deduct mortgage insurance premiums as interest. The mortgage debt exclusion has expired, which allowed underwater homeowners to exclude from taxable income the amount of any mortgage debt forgiveness granted to them by a bank.
Many of the tax credits available for energy-efficient home improvements also expired at the end of 2013, including those for home heating and cooling systems, insulation, windows and sealing — although credits for certain plug-in electric vehicles and solar and wind technologies will remain in effect through 2016.
So far, we’ve focused a lot of attention on tax increases and expired deductions and credits. But what are some of your favorite new tax breaks or deductions available to taxpayers?
As an active supporter of entrepreneurship and small business, I like the simplified home office deduction, particularly since economic contraction has motivated many Americans to start their own home-based businesses.
Under the new rule, you can bypass detailed expense records and simply deduct $5 for every square foot of home office space used, up to a maximum of 300 square feet, or $1,500. The simplified expense is recorded on Schedule C rather than Form 8829, and allows you to separately deduct mortgage interest and real estate taxes on Schedule A.
I also like the new $500 carry-over for health care flexible spending accounts, or FSAs. Employers now can allow employees to carry over up to $500 of any unused balance from the previous year, for use at any time during the next FSA accounting period.
Higher income taxpayers are going to pay more.
You’re going to figure this out in a few months when you file your tax return. And it’s no fluke. It will happen again in 2014.
First, the top tax rate for taxpayers is now 39.6%. We haven’t seen those kind of rates in almost 15 years. Those Bush-era tax cuts have finally expired, giving us the 20th century tax rates (gosh, that sounds really, really old). How high will it go? The 39.6% tax rate kicks in at $400,000 for individual taxpayers and $450,000 for married couples filing jointly.
All wages are subject to Medicare tax. That hasn’t changed. But now, taxpayers who make over $200,000 ($250,000 for married taxpayers) will be subject to the Medicare surtax. If that’s you, a Medicare surtax will be tacked on to your wages, compensation, or self-employment income over that amount. The amount of the surcharge is .9%.
Even if you aren’t affected by the Medicare tax surcharge, you still may be subject to the Net Investment Income Tax (NIIT) if you have both net investment income and modified adjusted gross income (MAGI) of at least $200,000 for an individual taxpayer and $250,000 for taxpayers filing as married. Net investment income includes items like interest, dividends, capital gains, rental and royalty income, and certain income from businesses. It doesn’t include wages, unemployment compensation, operating income from a nonpassive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain Qualified Plans. For the entire details on the tax – and I mean entire – check out my colleague’s “definitive” answers on the subject.
The limitation for itemized deductions – the Pease limitations, named after former Rep. Don Pease (D-OH) – claimed on individual returns for tax year 2014 will begin with incomes of $254,200 or more ($305,050 for married couples filing jointly). The Pease limitations were slated to be reduced beginning in 2006 and eliminated in 2010; as with the other tax cuts, the elimination was extended through the end of 2012. The limitations were brought back in 2013 at the original thresholds, indexed for inflation. The limitation reduces itemized deductions by 3% of the amount by which your adjusted gross income (AGI) exceeds those thresholds, up to a maximum reduction of 80%. That’s a complicated way of saying that your deductions are limited as your income increases.
Kind of a “tag along” provision is the personal exemption phaseout (PEP). Phase-outs for PEP in 2014 begin with AGI of $254,200 for individuals and $305,050 for married couples filing jointly; the personal exemptions phase out completely at $376,700 for individual taxpayers ($427,550 for married couples filing jointly).
It’s not just higher income taxpayers who will feel a difference: taxpayers who are affected by the Affordable Care Act could also feel the pain in 2014. If you do not have health insurance in 2014 – and you don’t otherwise meet certain exemptions – you’re going to have to pay up. The Internal Revenue Service calls it a “shared responsibility payment.” Other folks call it a penalty. Still others call it a tax or a fee. No matter what you call it, if you don’t have health insurance and don’t otherwise meet certain provisions, you’ll have to cough up either 1% of your taxable income or a flat fee of $95 per uninsured adult and $47.50 per child (up to $285 for a family), whichever amount is higher. But don’t fret just yet: the penalty is due when you file your 2014 tax return in April 2015. By then, you’ll be paying even more: the flat fee increases to $325 in 2015 and $695 in 2016. Ouch.
There is some good news. The self-employed get something of a break in 2014: there is an option to claim a new, simplified deduction for a home office. The deduction is equal to $5/square foot of home office space – up to a maximum of 300 square feet. It’s an easy calculation ($5 x the number of square feet) and beats figuring out your own expenses and pro-rating them though that’s still an option if that works out better for you. The per square foot calculation is intended to save hours more than dollars. The deduction made its first appearance in 2013 but you can also take the deduction in 2014.
The year 2014 will see more married same-sex couples. The Supreme Court struck down the 1996 Defense of Marriage Act (DOMA) in 2013, leaving the definition of marriage to the individual states. The result, from a tax perspective, is that the IRS will consider as legally married all couples who are legally married. Even more interesting, the IRS will recognize a legally married same sex couple regardless of whether the couple currently lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.
2014 also has the distinction of ushering in new Foreign Account Tax Compliance Act (FATCA) deadlines. Among them, FATCA withholding on new accounts will become effective July 1, 2014. That reflects a six-month delay from the previous January 1, 2014, deadline. 2014 will also mark deadlines for the completion of new due diligence and registration requirements – bound to cause confusion and irritation for international taxpayers. Since the FATCA rollout has been far from smooth to date, expect more FATCA news as the year passes.
And like a television infomercial… wait, there’s more! 55 tax breaks expired at the end of 2013 (that number alone is indicative of how bloated our Tax Code has become). Here’s a look at some of what you’ll miss out on in 2014, assuming no action from Congress:
- Charities won’t be able to easily snatch up retirement plan proceeds: a provision which allowed seniors to make direct gifts to a qualifying charity of up to $100,000 from their individual retirement accounts (IRAs) without reporting it first as income expired at the end of 2013.
- Teachers say goodbye to a tax deduction of up to $250 of out-of-pocket costs for school and classroom related supplies. The best part of that deduction? It was “above the line” meaning that teachers could claim the deduction even if they didn’t itemize.
- Also lost? Another “above the line” deduction – this one for tuition and fees. The deduction of up to $4,000 was available for qualified tuition and related expenses that you paid for yourself, your spouse, or a dependent. It’s now gone.
- A number of energy-efficient home improvement tax credits took a tumble. The credit of up to $500 for the installation of qualified insulation, windows, doors and roofs as well as certain water heaters and qualified heating and air conditioning systems evaporated as of December 31, 2013. The credit for solar hot water heaters, solar electric equipment and wind turbines is slated to stick around until 2016.
- Next on the list? The provision that allowed residents to deduct state and local sales and use taxes instead of state and local income taxes on their Schedule A. That benefited taxpayers, in particular, in states where there is no state income tax or relatively low state income taxes.
- Underwater homeowners also lost their available tax break when the clock struck midnight on New Year’s Eve. The Mortgage Forgiveness Debt Relief Act, which was signed into law by President George W. Bush in 2007, offered an exception to the rule that forgiven debt would be treated taxable income. Under the law, qualifying homeowners could exclude forgiven debt on a private residence that was the result of a renegotiated mortgage, short sale or foreclosure. Now, that debt is reportable – and taxable – as income until it means another exclusion.
- Finally, business owners will feel the loss of the Section 179 expense deduction. The deduction allowed small and mid-size business owners to immediately deduct an amount used to obtain qualifying equipment rather than hack the deduction into pieces over time according to a depreciation schedule. It’s a nice allowance and, until this year, business owners could deduct up to a hefty $500,000 of qualifying assets, a sizable bump from the old law. In 2014, the limit drops to $25,000. Not a typo. It was half a million dollars and now it’s just $25,000.
There are a few “tax extender” bills being tossed around that would retroactively reinstate some of the more popular tax deductions. We will update you as news becomes available.